24 | RKL 2018 Year-End Tax Planning Guide RKL 2018 Year-End Tax Planning Guide | 25 FOREIGN INCOME TAX REFORM CHANGES In addition to rate cuts and deduction changes, tax reform ushered in a significant shift in the treatment of companies doing business overseas. Previously, the U.S. operated with a worldwide system of taxation, foreign corporation earnings were generally taxed when distributed and anti-deferral rules taxed certain earnings currently, while foreign tax credits helped mitigate double taxation. Tax reform moves the U.S. closer to a territorial system of taxation by implementing a new dividends received deduction for foreign-source income distributed to U.S. shareholders of foreign corporations, charges a one-time “transition tax” on earnings and profits held abroad, limits the applicability of foreign tax credits and expands anti-deferral provisions. Below, you’ll find an overview of four key reforms to international tax law. Mandatory Repatriation The new tax law mandates that accumulated earnings held offshore are deemed to be repatriated and subject to a transition tax at a reduced tax rate. This one-time tax is applicable to shareholders who own 10 percent, directly or indirectly, of a specified foreign corporation (SFC). The base for the tax is the accumulated foreign earnings of the SFC since 1986 that have not previously been taxed in the U.S. Two preferential tax rates will be applied to a U.S. shareholder’s allocable share of post-1986 deferred foreign income. A 15.5 percent rate will be applied to the portion of earnings representing liquid assets such as cash, accounts receivable, certificates of deposit, government securities, etc. An 8 percent tax rate will be applied to the remainder of the allocated amount. An election is available to pay the tax on an installment basis over eight years or until a triggering event occurs (sale, liquidation, or cessation of the business, failure to pay an installment). The first installment of transition tax is due by the original due date of the shareholder’s return for the last tax year beginning before January 1, 2018. S Corporations are allowed a special election to defer the tax completely until a triggering event occurs or the entity ceases to be an S Corporation. Territorial Tax System Tax reform moves from the previous system of worldwide taxation, in which income of U.S. citizens and residents is taxed in the U.S. regardless where it is earned, and closer to a territorial system, in which tax applies to income sourced to a particular jurisdiction. The new “participation exemption”, in the form of a 100 percent dividends received deduction, helps transition the U.S. toward a territorial system. This deduction is allowed against the foreign-source portion of distributions from specified 10 percent foreign corporations (those owned at least 10 percent by a domestic corporation). It is only available to U.S. C Corporations. Expansion of Anti-Deferral Provisions While the participation exemption effectively excludes foreign-source income from U.S. taxation for U.S. C Corporations, provisions of existing law meant to prevent certain types of earnings from being held offshore long-term, such as Subpart F income and Section 956 Inclusions, have been retained under the law for all taxpayers and have been expanded to encompass new categories of income. Specifically, the law provides for a minimum tax on “Global Intangible Low-Taxed Income” (GILTI). GILTI includes not only intangible income, but all income earned by a controlled foreign corporation (CFC) above a 10 percent return on its depreciable tangible property used to generate the income. A deduction meant to reduce the tax rate on GILTI income by 50 percent is only available to C Corporations. Reduced Rate on High-Margin Exports As a counterbalance to GILTI, Congress created an export incentive in the form of a deduction for foreign-derived intangible income (FDII). Income from the export of goods and services for use in a foreign country will generally be eligible for the FDII deduction if profit is above a 10 percent return on depreciable tangible property used to generate the income. The net effect of the deduction is intended to reduce the tax rate on such income to 13.125 percent. This deduction is also only available to C Corporations. RKL 2018 Year-End Tax Planning Guide | 25